expectation that these costs will be repaid at the government rate. Indirect subsidies to the
military divisions are limited to 4% of the company’s annual sales and prohibit
production subsidies and, in addition, limit the government from offering buyers low
interest rates.
This agreement lowered subsidies from estimates of 7.5% to 12% of the cost of
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The Superjumbo By exceeding the limit set by the 1992 agreement, the European
governments risked retaliation by the United States. However, their strategic behavior
may have been worthwhile since Airbus is now the only producer of the new double-
National Welfare In particular, if the profits earned by Airbus from the A380 outweigh
the cost of the subsidy, European welfare will rise. This outcome would be more likely
Boeing is also having difficulties in the production of the 787 Dreamliner. As of February
2016, Boeing delivered 380 and has 1,143 orders. The outcome of the welfare from the
H E A D L I N E S
WTO Panel to Review EU‒U.S. Civil Aircraft Dispute
The EU and the United States have been engaged in many trade disputes and legal battles
over the years, filing complaints with the WTO regarding subsidies and supports that
both governments have granted to their respective aircraft companies. A WTO dispute
8 Conclusions
Export subsidies are used by many nations in many industries strategically to prop up
prices, raise real incomes, and create producers surplus but often at the expense of
consumers. For example, in agricultural countries, the export subsidies raise the income
of farmers but simultaneously raise prices for consumers. For a small exporting country,
the net loss of an export subsidy is similar to that of a tariff.
By contrast, the welfare implication of an export subsidy is different from a tariff for a
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do not specifically target exports and thus excess supply indirectly spills over into the
export markets, resulting in less severe losses for the exporting country. In the high-tech
TEACHING TIPS
Tip 1: Nash Equilibrium
Students who have not taken a course in game theory may have difficulty with the
concept of a Nash equilibrium. If this is the case in your class, it may be helpful to spend
extra time reviewing this important concept before covering Chapter 10.
Tip 2: Agricultural Subsidies and the Doha Round
Agricultural subsidies can be quite complex in terms of who they may benefit or harm.
This fact is well demonstrated by the current state of the Doha Round, and more
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Tip 3: High–Technology Export Subsidies
Chapter 10 tackles the subject of strategic trade using the example of Europe and the
IN–CLASS PROBLEMS
1. What are export subsidies? Why do countries use them? Provide examples of such
support programs.
Answer: An export subsidy is a payment given by the government to firms for every
2. Suppose Boeing and Airbus are deciding whether to invest in R&D to improve the
quality of their medium-capacity planes. Given the following payoff matrix in millions of
dollars, what is the Nash equilibrium of the game?
3. Refer to Problem 2. Suppose the governments of Europe seek to expand Airbus’
international market share by providing the European aircraft producer with a subsidy of
$40 million for R&D.
a. Redraw the payoff matrix and find the Nash equilibrium.
b. Is the subsidy successful in increasing European welfare? Explain.
Answer: After subtracting the $40 million in subsidy from Airbus’ profit, we see
4. Refer to Problems 2 and 3. Suppose the U.S. government decides to support Boeing
with a matching subsidy.
a. Redraw the payoff matrix and find the Nash equilibrium.
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b. How do these subsidies affect welfare in the United States and Europe?
Answer: The net effect of the R&D subsidies on the United States and Europe
can be summarized as follows:
European Welfare
United States Welfare
Gain in producer profits: +100
Gain in producer profits: +110
Revenue cost of subsidy: −40
Revenue cost of subsidy: −40
Net gain in European welfare: 60
Net gain in United States welfare: 70
2 give higher payoffs than the case in which Boeing and Airbus receive the export
subsidy.
5. Tradia is a small export country. Suppose initially that the world price is $150. Due to
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successful lobbying activities, Tradia producers will now receive a subsidy of $25 per
unit exported. Use the following figure to answer the questions below.
a. Do you expect Tradia to export more with the subsidy? If so, by how much?
Answer: The producers will export more because they are guaranteed to receive a
b. What is the change in consumer surplus due to the subsidy?
Answer: The loss in consumer surplus is equal to areas a + b.
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c. What is the gain/loss in producer surplus with the subsidy?
Answer: The gain in producer surplus is equal to areas a + b + c.
d. How does the subsidy affect welfare in Tradia?
Answer: The net effect on welfare can be summarized by the following:
6. Islandia is a small exporting country with supply and demand given by the following
equations:
D = 100 − 5P
S = 10P − 50
Suppose the free-trade world price is $12 per unit.
a. In the absence of any barriers to trade, what are the domestic consumption and
production? How much is exported?
Answer: The amount exported is 30 units.
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b. Suppose the Islandia government offers the island producers an export subsidy of
$3 per unit. In addition, the government imposes a tariff of $3 per unit on imports.
Calculate the price paid and quantity demanded by island consumers.
Answer: PW + s = $12 + $3 = $15
c. Calculate the net effect of the export subsidy on Islandia welfare.
Answer:
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7. It is more efficient for the government of a small country to impose an import tariff
than a production subsidy to stimulate output because it does not have to pay the
producers directly. Comment.
Answer: Unlike an import tariff, a production subsidy does not alter consumption
8. Suppose the supply and demand for Continentia, a large country, is as follows:
D = 900,000 − 150P
S = 100,000 + 50P
Assume that the free–trade world price is $5,000 per unit. Further assume that the
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Continentia government offers an export subsidy that increases the domestic market price
to $5,500 and lowers the world price to $4,500. However, starting next month, the
Continentia government will be removing the export subsidy in compliance with the
latest international trade pact.
a. What is the impact of the removal of the subsidy on domestic consumers?
Answer: The quantity demanded by consumers increases from 75,000 to 150,000
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Demand without export subsidy:
b. What is the change in producer surplus due to the movement to free trade?
Answer: The quantity supplied by producers decreases from 375,000 to 350,000
because they receive a lower price without the export subsidy. The net loss to producers
Supply with export subsidy:
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c. What is the net effect of moving to free trade on Continentia welfare?
Answer: The net effect on Continentia from the removal of the export subsidy is
positive. Given that Continentia is a large country, the export subsidy resulted in
d. Would Continentia consumers support or oppose the policy for free trade? What
about producers? Explain.
Answer: Consumers would support the removal of the export subsidy because they
9. Consider a small exporting country. Compare the cost to the government and the net
effect on welfare between an export and production subsidy in the amount of s per unit.
Answer: With an export subsidy, the loss in consumer surplus is equal to the areas a
+ b because the price in the domestic market increases to PW + s, leading the quantity
10. Suppose Home is a small country trading with a large exporter. The supply and
demand curve for Home is illustrated by the following figure, where PW denotes the free–
trade world price. Assume that the Foreign government supports its producer with an
export subsidy that lowers the world price to P*.
Should Home consider levying a countervailing duty that would raise the import price
back to PW (i.e., the level without the subsidy)? Answer by ranking the following
situations. Be sure to justify your ranking.
(1) Home without the foreign export subsidy
(2) Home with the foreign export subsidy
(3) Home with the foreign export subsidy and the countervailing duty
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11. Recall that WTO guidelines allow an importing country to impose a countervailing
duty to raise the price of the imported good in response to illegal government support
such as an export subsidy on the part of the exporting country. Go to the WTO website
(http://www.wto.org/english/tratop_e/scm_e/scm_e.htm) to determine which five sectors
were the subject of the largest number of claims with the WTO from 1995 to 2014
(scroll down to “Countervailing Sectoral Distribution of Measures: By Reporting
Member”).
Answer:
Section
Description
XV
Base Metals and Articles of Base Metal
IV
Prepared Foodstuffs; Beverages, Spirits and
Vinegar; Tobacco and Manufactured Tobacco
Substitutes
VII
Plastics and Articles Thereof; Rubber and Articles
Thereof
I
Live Animals; Animal Products
XI
Textiles and Textile Articles